The choice of payment method in European mergers & acquisitions Mara Faccio Owen Graduate School of Management Vanderbilt University 401 21 st Avenue South Nashville, TN 37203 and Ronald W. Masulis Owen Graduate School of Management Vanderbilt University 401 21 st Avenue South Nashville, TN 37203 Version: February 28, 2004 We thank Utpal Bhattacharya, Harry DeAngelo, Tim Loughran, Rob Stambaugh (the editor) and especially an anonymous referee for his/her insightful comments and suggestions. We also want to thank seminar participants at the Melbourne Business School, University of Miami, University of New South Wales, University of Notre Dame, University of Pittsburgh, University of South Carolina, Vanderbilt University and the 16 th Australasian Finance and Banking Conference for helpful comments. We are also appreciative of research support from the Financial Markets Research Center at Vanderbilt University.
The choice of payment method in European mergers & acquisitions Abstract We study merger and acquisition (M&A) payment choices of European bidders for publicly and privately held targets in the 1997-2000 period. Europe is an ideal venue for studying the importance of corporate governance in making M&A payment choices, given the large number of closely held firms, and the wide range of capital markets, institutional settings, laws and regulations. The tradeoff between corporate governance concerns and debt financing constraints is found to have a large bearing on the bidder s payment choice. Consistent with earlier evidence, we find that several deal and target characteristics significantly affect the method of payment choice. 1
Introduction Global M&A activity has grown dramatically over the last ten years, bringing with it major changes in the organization and control of economic activity around the world. Yet, there is much about the M&A process that we do not fully understand, including the choice of payment method. Given the large size of many M&A transactions, the financing decision can have a significant impact on an acquirer s ownership structure, financial leverage, and subsequent financing decisions. The financing decision can also have serious corporate control, risk bearing, tax and cash flow implications for the buying and selling firms and shareholders. In this study, we examine the choice of payment method and its determinants across a large sample of European M&A transactions. While most M&A research is based on US transactions, focusing on U.S. data has the disadvantage of holding many institutional factors relatively fixed. By studying merger activity across a broad sample of European bidders, we are better able to evaluate the importance of a wide range of ownership structures, corporate governance rules, corporate laws, securities regulations and market conditions, which is not possible with U.S. data. With respect to ownership concentration, Faccio and Lang (2002) document that 63 percent of their sample of listed firms across 13 Western European countries have a single large shareholder, who directly or indirectly controls at least 20 percent of their votes. This is in sharp contrast to the U.S. where only 28 percent of listed US corporations have a large shareholder who controls 20 percent or more of its votes. 1 Moreover, European stock markets operate under significantly different rules and regulations, have more variable trading activity and exhibit widely varying industry concentration levels compared to the US. Unlike most earlier studies, our primary focus is on the relative importance of threats to bidder corporate control and to its financial strength when choosing the form of M&A consideration. In making an M&A currency decision, a bidder is faced with a choice between using cash and stock as deal consideration, which have conflicting effects. Given that most bidders have limited cash and liquid assets, cash offers generally require debt financing. 2 As a consequence, a bidder implicitly faces a choice of debt or equity financing, which involves a tradeoff between corporate control concerns of issuing 2
equity and rising financial distress costs of issuing debt. Thus, a bidder s M&A currency decision can be strongly influenced by its debt capacity and existing leverage. It can also be strongly influenced by management s desire to maintain the existing corporate governance structure. In contrast, a seller can be faced with a tradeoff between the tax benefits of stock and the liquidity and risk minimizing benefits of cash consideration. For example, sellers may be willing to accept stock if they have a low tax basis in the target stock and can defer their tax liabilities by accepting bidder stock as payment. On the other hand, sellers can prefer cash consideration to side step the risk of becoming a minority shareholder in a bidder with concentrated ownership, thereby avoiding the associated moral hazard problems. Unfortunately, due to data limitations, this seller trade off can not be easily measured. Looking more carefully at a bidder s financing choice, it is clear that its corporate governance structure can be seriously impacted by the choice of merger currency, since stock issuance dilutes a dominant shareholder s voting power. If preserving control is important to bidder management, then they have incentives to select cash financing over stock financing, especially under circumstances where continued corporate control is threatened (for example, see Shleifer and Vishny (2003) for a discussion of control benefits). The corporate control incentives to choose cash are likely to be strongest when a target s share ownership is concentrated and a bidder s largest shareholder has an intermediate level of voting power in the range of 20 to 60 percent; a range where she is most vulnerable to a loss of control under a stock financed acquisition. These incentives diminish if a bidder or target is diffusely owned, since the bidder s controlling block is not threatened. On the other hand, when a shareholder has supermajority voting rights, stock financing is unlikely to threaten her continued control. In this case any reluctance to issue stock in an acquisition is greatly weakened. These predictions are in the spirit of the Harris and Raviv (1988) and Stulz (1988) models, which show that managers with significant ownership positions are reluctant to seriously dilute their voting power and risk loss of control by issuing stock. Under existing theories of capital structure, debt capacity is a positive function of tangible assets, earnings growth and asset diversification and a negative function of asset volatility (Hovakimian, Opler and Titman, 2001). Firms with greater tangible assets can borrow more privately from banks and publicly 3
in the bond market. Since larger firms are generally more diversified, we expect them to have a lower probability of bankruptcy at a given leverage ratio and thus, greater debt capacity. These financing constraint and bankruptcy risk considerations can also reduce a lenders willingness to finance a bidder s cash bid, especially in relatively large deals. In section I we review the theories and evidence concerning M&A financing decisions, while in section II we document data sources and present descriptive statistics on deal, bidder and target characteristics by type of M&A financing decision. After reviewing the methodologies we use, we present and interpret our empirical findings on the determinants of the M&A financing choice and explore the robustness of these results. The last section summarizes our empirical findings and conclusions. I. Hypotheses and Predictions Derived from the Prior Literature A. Literature Review A number of earlier studies have analyzed M&A financing decisions. Hansen (1987), Stulz (1988) and Fishman (1989) develop theories of acquisition payment choice based on asymmetric information and the threat of competitive bidding. 3 Of these theories, only Stulz focuses primarily on corporate control concerns. He posits that M&A financing decisions are affected by management s desire to maintain corporate control and garner continued personal benefits. Managers have incentives to maintain or increase their voting power since the probability of a change in control rises as their fractional voting power falls. Stulz observes that while managers wealth constrains their shareholdings, growing firms can rely on debt financing to maintain managements ownership level and voting power. However, risk-averse managers bear greater portfolio risk as increasing debt raises their stock risk. This manager trade-off results in an optimal debt level for a firm and an optimal manager investment in shares, which generally precludes the corner solution of managers of growing firms preserving their majority control through continued debt financing. Amihud, Lev and Travlos (1990), Martin (1996) and Ghosh and Ruland (1998) empirically study the determinants of M&A payment method and investigate the importance of buyer management 4
stockholdings on US acquisitions over the 1978-1988 period. All three studies conclude that buyer management shareholdings have a negative effect on stock financing, consistent with a corporate control motive. Amihud, Lev and Travlos report the results of an early test of the Stulz (1988) theory where they estimate a probit regression to explain the choice of stock versus cash financed acquisitions as a function of officer and director share ownership, and target size. They find manager share ownership measures have a significant negative relationship to stock financing. However, there are few statistical controls for differences in deal characteristics across the sample. Similar to the Amihud, Lev and Travlos study, the Ghosh and Ruland analysis covers large deals involving publicly listed targets. 4 Only the Martin study includes privately held targets. However, his analysis does not differentiate between them and public targets. Using a sample of 846 completed acquisitions of public and private firms by NYSE and AMEX listed buyers, Martin reports that high buyer stock ownership lead to more stock financing, while an intermediate range of shareholdings by buyer managers reduce stock financing. 5 Most of the early empirical literature on M&A financing decisions concentrates on the market reactions to their announcement, with the determinants of these financing decisions generally given limited attention. For acquisitions of publicly traded targets, Travlos (1987), Wansley, Lane and Yang (1987), Amihud, Lev and Travlos (1990), Servaes (1991), and Brown and Ryngaert (1991) document significant negative average announcement returns to acquirers when the method of payment is stock rather than cash. One dominant explanation for this pattern is that stock financing creates an adverse selection effect similar to a seasoned stock offering. A potential concern with these studies is that none of them controls for endogeneity in the financing decision when measuring announcement effects. In this regard, this study develops a predictive model that enables researchers to better control for endogeneity or market expectations of these financing decisions. 5
B. Hypotheses Explaining M&A Financing Decisions and their Empirical Predictions Following Martin (1996) we classify the form of M&A payment into cash and stock where cash payments are defined to include cash, non-contingent liabilities and newly issued notes and stock is defined as shares with full voting rights or inferior voting rights. 6 We take two approaches to analyzing the method of payment decision. First, we measure the proportion of cash and stock in each deal. The variables PERCENT CASH and PERCENT STOCK measure these proportions. Second, we classify deals into those containing only cash (CASH ONLY), only stocks (STOCK ONLY), or a mixture of cash and stocks (MIXED PYMT). In assessing potential determinants of an M&A payment method, our focus is on a bidder s M&A financing choices, recognizing that targets can also influence the final terms of an M&A deal. However, if a target s financing choice is unacceptable to the bidder, then the proposed M&A transaction is likely to be aborted or else the bidder can make a hostile offer on its own terms. For a deal to succeed, the bidder must be satisfied with the financial structure of the deal. Moreover, a bidder can have strong preferences toward one financial structure over another because of control threats to its dominant shareholders, its unused debt capacity and available liquid assets, which together determine a deal s financial feasibility and attractiveness to the bidder and target. Several other proxies and control variables are discussed later in the sensitivity analysis section. Bidder and Target Considerations: B1. Corporate Control Bidders controlled by a major shareholder should be reluctant to use stock financing when this causes the controlling shareholder to risk losing control (Amihud, Lev, and Travlos, 1990, Stulz, 1988, Jung, Kim and Stulz, 1996). Assuming control is valuable, 7 the presence of dominant shareholder positions should be associated with more frequent use of cash, especially when the controlling shareholder s position is threatened. To capture this effect, we use the ultimate voting stake held by the largest controlling shareholder (CONTROL). For example, if a family owns 50% of Firm X that owns 6
20% of Firm Y, then this family controls 20% of Firm Y (the weakest link in the chain of control). If we create a pyramid where the family also owns 50% of Firm Z that also owns a 40% of Firm Y, then the family owns 60% of Firm Y (the sum of the weakest links in the two chains of control). This variable comes from Faccio and Lang (2002), and captures the effects of complex control structures. A bidder with diffuse or highly concentrated ownership is less likely to be concerned with corporate control issues. In line with this argument, Martin (1996) documents a significantly negative relationship between the likelihood of stock financing and managerial ownership only over the intermediate ownership range. Similar evidence is reported in Ghosh and Ruland (1998). Therefore, we incorporate the possibility of a non linear relationship between the method of payment and the voting rights of a bidder s controlling shareholder by estimating both a linear and cubic specification for the ultimate voting control percentage of the bidder s largest shareholder. In our robustness analysis, we also estimate a spline function for this variable. Corporate control concerns in M&A activity can manifest themselves in more subtle ways. Concentrated ownership of a target means that a stock financed acquisition can create a large blockholder, threatening the corporate governance of the acquirer. If the seller is closely held or is a corporation disposing of a division, then ownership concentration tends to be very concentrated. This implies that financing the M&A deal with stock can create a new blockholder in the bidder. While the risk of creating a new bidder blockholder with stock financing is higher when a target has a concentrated ownership structure, this is especially true when relative size of the deal is large. To capture the risk of creating a large blockholder when buying a target with stock financing, we employ CONTROL LOSS, the product between the target s control block and the deal s relative size. The relative deal size is computed as the ratio of offer size (excluding assumed liabilities) to the sum of a bidder's equity pre-offer capitalization plus the offer size. The target s controlling blockholder is assumed to have 100% ownership for unlisted targets and subsidiary targets. For listed targets, we determine the pre-acquisition control structure of the target using the sources listed in Appendix B. 7
B2. Collateral, Financial Leverage and Debt Capacity We use the fraction of tangible assets as our primary measure of a bidder s ability to pay cash, financed from additional borrowing. COLLATERAL is measured by the ratio of property, plant and equipment (PPE) to book value of total assets at the year end prior to the bid. Myers (1977) argues that debtholders in firms with fewer tangible assets and more growth opportunities are subject to greater moral hazard risk, which increases the cost of debt, often making stock more attractive. Hovakimian, Opler and Titman (2001) find that a firm s percentage of tangible assets has a strong positive influence on its debt level. We also control for a bidder s financial condition with its leverage ratio, FIN L LEVERAGE. Since cash is primarily obtained by issuing new debt, highly levered bidders are constrained in their ability to issue debt and as a consequence use stock financing more frequently. A bidder s financial leverage is measured by the sum of the bidder s face value of debt prior to the M&A announcement plus the deal value (including assumed liabilities) divided by the sum of the book value of total assets prior to the announcement plus the deal value (including assumed liabilities). This captures the bidder s post-deal leverage if the transaction is debt financed. This measure differs from Martin (1996) who uses a pre-deal bidder leverage measure adjusted for an industry mean and reports an insignificant effect. Companies may establish connections with banks through cross ownership of stock or through interlocking directorships (which are in fact much less restricted than stock ownership in our countries). As in the case of group affiliation, these interlocking directors may facilitate easier access to debt financing. We therefore build an indicator variable, INTERLOCK, which takes the value of one if a top bidder director (CEO, president, vice-president, or secretary) is a director of a bank, and is zero otherwise. 8 Bidder size is likely to influence its financing choices. Larger firms are more diversified and thus, have proportionally lower expected bankruptcy costs. They also have lower flotation costs and are likely to have better access to debt markets, making debt financing more readily available. Thus, cash financing should be more feasible in the case of larger firms. Larger firms are also more apt to choose cash 8
financing in smaller deals due to its ease of use, provided they have sufficient unused debt capacity or liquid assets. Further, the use of cash allows the bidder to avoid the significant costs of obtaining shareholder approval of pre-emptive rights exemptions and stock authorizations and the higher regulatory costs of stock offers. We measure bidder asset size by the log of pre-merger book value of assets in dollars (TOTAL ASSETS). In addition to bidder control and financing considerations, we need to take into account several other bidder characteristics. B3. Relative Deal Size, Bidder Stock Price Runup and Asymmetric Information Hansen (1987) predicts that bidders have greater incentives to finance with stock when the asymmetric information about target assets is high. 9 This information asymmetry is likely to rise as target assets rise in value relative to those of a bidder. Yet, when stock is used in relatively larger deals, it produces more serious dilution of a dominant shareholder s control position. Finally, as bidder equity capitalization rises, concern about its financing constraint falls, since there is a relatively smaller impact on its overall financial condition. We proxy for these effects with REL SIZE, which is computed as the ratio of deal offer size (excluding assumed liabilities) divided by the sum of the deal s offer size plus the bidder s pre-offer market capitalization at the year-end prior to the bid. 10 Both Myers and Majluf (1984) and Hansen (1987) predict that bidders will prefer to finance with stock when they consider their stock overvalued by the market and prefer to finance with cash when they consider their stock undervalued. As uncertainty about bidder asset value rises, this adverse selection effect is exacerbated. Korajczyk, Lucas, and MacDonald (1991) argue that new stock investors bear greater adverse selection risk after stock runups. Finally, if a bidder has recently experienced a sizable stock price gain, then its existing shareholders experience lower dilution of their voting power when stock financing is employed. Martin (1996) finds evidence consistent with this adverse selection prediction. For a sample of publicly traded targets, Travlos (1987) finds that stock financed M&A deals exhibit much larger negative announcement effects than cash financed deals. He concludes this is consistent with the empirical validity of an adverse selection effect. We use as a proxy for bidder overvaluation (or 9
undervaluation), RUNUP, calculated from a bidder s buy and hold cumulative stock return over the year preceding the M&A announcement month. In addition to bidder considerations, we need to take into account typical target considerations. These preferences are related to risk, liquidity, asymmetric information and home bias. T1. Unlisted Targets and Subsidiary Targets We use an indicator variable, UNLISTED TARGET, to control for listing status where the variable takes a value of one if the target is a stand-alone company, not listed on any stock exchange and is zero for listed targets and unlisted subsidiaries. When an M&A deal involves an unlisted target, a seller s consumption/liquidity needs are also likely to be important considerations. These sellers are likely to prefer cash given the illiquid and concentrated nature of their portfolio holdings and the often impending retirement of a controlling shareholder-manager. Likewise, corporations selling subsidiaries are often motivated by financial distress concerns or a desire to restructure toward their core competency. In either case, there is a strong preference for cash consideration to realize these financial or asset restructuring goals. A likely consequence is a greater use of cash in such deals, since bidders are frequently motivated to divest subsidiaries to finance new acquisitions or reduce their debt burden. SUBSIDIARY is an indicator that equals one when the (unlisted) target is a subsidiary of another firm, and equals zero otherwise. As noted earlier, these two target ownership structures are also likely to elicit bidder corporate control concerns given their concentrated ownership. Thus, bidders are likely to prefer cash financing of such deals, especially as they become relatively large. T2. Cross-Industry Deals and Asymmetric Information Seller reluctance to accept bidder stock as payment should rise as the asymmetric information problem worsens with greater uncertainty about bidder equity value and future earnings. This problem is also likely to be more serious for conglomerate mergers. In contrast, sellers are more apt to accept a continuing equity position in an intra industry merger, where they are well acquainted with industry risks and prospects. Therefore, we employ INTRA-INDUSTRY, a dummy that equals one if bidder and target are in the same industry (the primary three digit SIC codes coincide) and is zero otherwise. 10
T3. Cross-Border Deals, Local Exchange Listing and Home Bias In cross border deals, selling stock to foreign investors can entail several problems. We are concerned with the possibility that investors have a home country bias in their portfolio decisions as documented in Coval and Moskowitz (1999), French and Poterba (1991) and Grinblatt and Keloharju (2001), among others. This can reflect a foreign stock s greater trading costs, lower liquidity, exposure to exchange risk and less timely, more limited access to firm information. These considerations lower seller demand for bidder stock. We define CROSS BORDER, as an indicator variable that equals one if bidder and target countries differ and is zero otherwise. T4. Bidder Investment Opportunities High growth bidders can make an attractive equity investment for selling shareholders. MKT- TO-BOOK, defined as a market value of equity plus book value of debt over the sum of book value of equity plus book value of debt prior to the bid, measures a bidder s investment in growth opportunities. We expect a higher market to book ratio to increase a bidder stock s attractiveness as M&A consideration. High market to book is also correlated with high levels of tax deductible R&D expenditures, along with low current earnings and cash dividends. These firm attributes lower a bidder s need for additional debt tax shield, making cash financing less attractive. These attributes are also attractive to high income bracket sellers due to their tax benefits. Jung, Kim and Stulz (1996) document a higher incidence of stock financing for higher market to book buyers. II. Data and Descriptive Statistics The initial sample includes all acquisitions announced over the four years between January 1997 and December 2000 by bidders from 13 European countries: Austria, Belgium, Finland, France, Germany, Ireland, Italy, Norway, Portugal, Spain, Sweden, Switzerland, and the UK. Announcements must be reported in Thomson Financial Securities Data s SDC, Worldwide Mergers & Acquisitions Database. This database covers public and private corporate transactions involving acquisition of at least 5% ownership of a target company. 11
All mergers and acquisitions must satisfy the following screening criteria. First, bidders need to be incorporated and listed on a stock market in one of the above listed major European countries. No restriction is imposed on a target s country of incorporation, its listing status, or the bid s outcome (i.e. both successful and unsuccessful bids are included). We use SDC to collect the two M&A partners identities, country, industry (3 digit SIC code) and determine whether their stocks are publicly listed, the deal s initial announcement date, dollar value, method of payment, legal form, and whether it is friendly or hostile. After this initial screening, we have complete information for 9,935 M&A announcements. Data on method of payment is hand collected based on descriptive information reported in SDC, rather than relying on SDC s method of payment variable because we found frequent inconsistencies between the two data fields. Second, to be included in the sample a bidder s financial accounting statements for the year-end prior to the offer must be reported in Worldscope. Although SDC provides data fields for bidder and target accounting information, it is often missing for European bidders. Third, bidder stock price data at the year end prior to the announcement must be available in Datastream. This data is used in constructing our measures of market valuation, stock risk, return, and liquidity. Fourth, bidder stock ownership and voting control data must be available. Stock ownership and voting control data are taken from Faccio and Lang (2002). 11 In order to minimize the loss of observations from merging these databases, Lexis Nexis, Extel Financial and Worldscope are used to identify company name changes. There are 4,342 observations where bidder names can be matched across all four datasets. We also require all M&A deals to be financed with cash, stocks, or a combination of cash and stock. After excluding 478 deals with earnouts, 12 we are left with 3,864 observations. We then exclude deals where the target nation places restrictions on foreign equity investments by domestic investors. This restriction only applies to a small sample of cross border deals in certain nations for some years. After all these exclusion, we are left with 3,667 observations by 1,349 bidders in our final sample. There are 741 firms making multiple bids where the frequency distribution is 274 firms making two bids, 163 making three bids, 102 making four bids, and 202 firms making 5 bids or more. 12
[Table I goes here] As seen in Table I, a large majority of deals involve UK bidders (65.3%). We have relatively few (i.e., less than 60) announcements by bidders incorporated in Switzerland, Belgium, Portugal and Austria. Although targets may be from any country, UK targets represent the largest group in our sample (47.0% of all targets). Similarly, targets incorporated in our 13 bidder countries represent 77% of the sample. US firms represent the largest fraction of the non European targets (12.4%). [Table II goes here] Table II presents descriptive statistics when deals are classified by financing method. Panel A shows that most European bids are entirely cash financed. Specifically, our M&A sample contains 2,942 (80%) pure cash deals, 416 (8.4%) mix of cash and stock deals and 309 (11.3%) pure stock deals. Mixed currency payments of cash and stocks on average contain a higher proportion of cash (56.9%) than stock (43.1%). In contrast, Andrade, Mitchell and Stafford (2001) report that 70% of M&A transactions by US firms in the 1990s involve stock financing, with 58% entirely stock financed. The proportion of all cash deals is highest in Austria (100%) and Portugal (90%), and lowest in the Scandinavian nations of Finland (66%) and Norway (69%). Cash financing is predominant across all countries, and more common than is suggested in previous European M&A studies. For example, Eckbo and Langohr (1989) report in a study of 306 tender offers for publicly traded French targets that over the period 1966-1982, 25% were at least partially stock financed. In our sample of French acquisitions, we find that only 21% of deals include at least some stocks. Of course our sample is not limited to publicly traded targets or tender offers, which is a likely source of the difference. Our evidence contrasts sharply with a previous study by Franks, Harris and Mayer (1988) who report that during 1955-85, 66% of UK M&A deals included at least some stock in its method of payment. Zhang (2003) reports that 63% of M&A deals completed over 1990-99 where bidder and target are London Stock Exchange listed include at least some stock payment. In contrast, for our sample of 2,394 UK acquisitions, only 20% of these deals involve some stock payment. However, both of these earlier studies of UK acquisitions are restricted to listed targets, which are more likely to use stock financed deals. When comparing the 13
frequency of payment types by listed targets, unlisted and subsidiary targets, we find that the frequency of cash deals is much lower for listed targets (60%), while the frequency of stock or mixed deals is much larger (40%). Unlisted and subsidiary targets exhibit substantially lower levels of stock or mixed financing (20% and 10%, respectively). Table II also shows that on average a bidder s largest blockholder ultimately controls 22% of its voting rights. This figure is substantially lower than that previously documented in Faccio and Lang (2002). One possible explanation for the difference is that bidders tend to be relatively large companies, which have a significantly more widely dispersed ownership. We explore this issue in the last part of our study. We also have a relatively large proportion of UK firms, which happen to have more widespread ownership than continental European companies. The countries with largest average level of dominant shareholder voting control are Austria (43%), Italy (40%), Portugal (36%) and Finland (36%) and the lowest are Ireland (19%) and the UK (18%). The corporate ownership structure of our bidders is in sharp contrast to previous US studies. Martin (1996) documents an average ownership level of 11% by all bidder officers and directors (including stock options). Ghosh and Ruland (1998) report average share ownership of 10.5% by all acquirer officers, directors and insiders. One reason for the smaller ownership level reported in these studies is that they focus on all directors, while we focus only on the dominant shareholder, who may or may not be a director. Table II, Panel B indicates that bidder, target, and deal specific attributes are quite different across method of payment categories. Bidders whose largest shareholder has voting power in the 20 to 60% range are more common in stock financed deals (33% of cases), while in mixed deals they are least common (25% of cases). This is surprising, given that stock financing is more likely to threaten the voting control of the dominant shareholder in the 20 to 60% range. However, cash financed deals are substantially smaller in size relative to bidder equity capitalization than either stock or mixed deals, which suggest a financial motive for the currency choice. The CONTROL LOSS variable is highest in mixed 14
(11.5%), and second highest in stock financed M&As (8.5%). This result also may be due to the larger relative size of stock deals. Bidders in cash financed deals have the highest percentage of collateral (38%); while bidders in stock financed deals have the lowest percentage of collateral (27%), and mixed deals have an intermediate level (31%). Financially constrained bidders choose stock financed deals more frequently. For 18% of all cash deals, a top director in the bidder is also a director of an affiliated bank; for mixed deals this figure is similar (19%), but for all stock deals it is substantially lower (11%). Bidders making pure cash acquisitions have larger total assets than bidders in pure stock financed deals. Average deal size (DEAL VALUE) for pure stock financed deals is dramatically larger than that for pure cash financed deals (i.e. 17 times larger); with the average mixed deal being of an intermediate size. The average size of a target relative to the bidder (REL SIZE) is highest for pure stock deals (18%) and lowest for pure cash deals (7%). The relative size of mixed deals averages 16%. Bidder stock price runup in the year prior to deal announcement (RUNUP) is highest for all equity deals and lowest for all cash deals. Consistent with our earlier analysis, the likelihood of a bidder and target being in the same industry (INTRA-INDUSTRY) is highest for pure stock deals and lowest for pure cash deals. Cross border transactions (CROSS BORDER) are more common in cash only deals (45%) than in stock only deals (31%) or mixed deals (22%). Mixed deals are more likely to involve free-standing unlisted targets (62% of cases) than all cash deals (47%) or all stock deals (30%). All cash deals are more likely to involve subsidiaries (41% of cases) than all stock deals (19%) or mixed deals (19%). The bidder s market to book ratio and its stock return s standard deviation are highest for stock only deals and lowest for cash only transactions. Table II, Panel B also shows that deals announced by UK and Irish bidders are substantially different from those announced by continental European bidders in terms of their corporate control structures, their potential borrowing capacity, as well as a number of other deal specific and target specific variables. While the above descriptive analysis is supportive of the empirical relevance of our 15
previously proposed explanatory variables, a proper assessment of their marginal effects on M&A payment form requires more detailed multivariate analysis. III. Methodology and Empirical Evidence A. Tobit Regressions Since our dependent variable is the cash portion of the M&A consideration, which must by definition be in the interval [0, 100], we use a two-boundary Tobit estimator. 13 In our estimation, we employ a general model of the form: y = x β + u (1) i ' i i where u i is an independently distributed error term assumed to be normal with zero mean and variance σ 2. The dependent variable has both left and right censoring so that: y i 0 = y i 100 if y i 0 if 0 < y i if 100 y < 100 i (2) where 0 and 100 are the censoring points. The parameters β, σ are estimated by maximizing the log likelihood function: l ( β, σ ) = i yi = 0 ' log F(( x β ) / σ ) + i log i 0< yi < 100 f (( y i ' x β ) / σ ) + i i yi = 100 ' log(1 F((100 x β ) / σ )) i (3) ' where f and F are the density and cumulative distribution functions respectively. Denoting φ[( x β ) / σ ], ' ' ' φ[(100 x β ) / σ ],, and by the respective symbols i Φ [( x i β ) / σ ] Φ[(100 x i β ) / σ ] φ 0, φ 100, Φ 0, and Φ100, the conditional prediction of y given x is: i i i 16
' E ( y i 0 yi 100) = x i β + σ ( φ0 φ100) /( Φ100 Φ0) (4) and the unconditional prediction of y i is: { Φ Φ } + σ { φ } + ( 1 Φ )100 ' E ( y i ) = x i β 100 0 0 φ100 100 (5) Finally, quasi-maximum likelihood (QML) White standard errors are used to adjust for heteroscedasticity in this panel data. Since we expect both bidder and target preferences to affect the offer price and its form of consideration, we would ideally like to simultaneously estimate equations capturing the two parties preferences. However, identification requires information about a target s stand alone value relative to its purchase price (takeover premium) as well as the form of payment. Access to information about a target s stand alone value is unavailable, given that most of these firms are privately held. This precludes estimating the alternative purchase prices conditional on form of payment. As a consequence, we have chosen to estimate a reduced form equation that includes both parties preferences as explanatory variables. [Table III goes here] By breaking the sample into the UK-Ireland and continental Europe, we can assess whether common law countries exhibit a distinctly different M&A financing relationships to the explanatory variables, especially with respect to bidder corporate control and debt financing constraints. Splitting the sample is further motivated by the high frequency of M&A transactions in the UK and Ireland, where shareholder concentration is much lower and borrowing capacity appears stronger. Tobit regressions of the percentage of cash consideration are presented in Table III for the full sample and the UK Ireland and Continental European subsamples. In each of these samples, we include measures of bidder corporate control and financial condition as well as a number of control variables. We measure bidder corporate control by the percentage of votes under the control of the largest shareholder and its square and 17
cubic values and a measure that proxies for the creation of a rival bidder blockholder if the deal is stock financed. We measure bidder financial condition by its portion of tangible assets, financial leverage, interlocking directors, and total assets. In the first regression in Table III Panel A we estimate the model for the full sample. We find that bidder voting control is significant and positive in the level and cubed value and negative for the squared value, where the transition points are 15.79 and 61.67 percent for the whole sample. 14 These cutoff points are substantially higher than those identified in the US literature, but close to the 20 and 60 percent cutoffs we employ in our spline estimation reported in the robustness section of the analysis. These estimates are consistent with control not being a serious concern at low levels of voting power, then becoming important at higher levels, but at very high levels again becoming less of a concern again. With high levels of control in a bidder, the dominant shareholder is less concerned with losing control due to a stock financed acquisition, probably because their position is only at risk in unusually large deals. The positive coefficient on the intermediate shareholdings level supports the previous findings of Amihud, Lev and Travlos (1990), Martin (1996) and Ghosh and Ruland (1998), though they did not find a negative coefficient for high management stockholdings. A bidder s payment choice can be constrained by several factors. A bidder with few excess liquid assets, few tangible assets and little unused debt capacity (i.e. high leverage relative to its industry) can be strongly constrained in its use of cash. Examining the effects of bidder financial condition, we find that when they have more tangible assets (collateral), they are more likely to choose cash as their M&A payment form, which is consistent with their debt capacity rising with collateral. 15 Financially constrained bidders with high leverage are more likely to use stock financing, which is consistent with bidder concern about substantially raising their likelihood of bankruptcy. Interlocking directors with a bank result in a significantly higher fraction of cash payment which can reflect greater access to debt. Lastly, we find that bidders with greater total assets are more likely to finance with cash as expected, which is consistent with their greater level of diversification. 18
A target s listing status is a proxy for its shareholder ownership structure. As expected, bidders of unlisted targets and subsidiary targets use cash significantly more often as their method of payment choice, while bidders of listed targets use stock financing more often. This evidence is consistent with bidder preference for cash financing when the risk of a control loss rises and a greater seller preference for cash when a target is privately held or a subsidiary. We document that a target s listing status has very high statistical and economic significance. This result is consistent with bidders avoiding stock financing to minimize corporate control threats, especially in acquisitions of subsidiaries which could be viewed as a serious threat given the divesting firm s financial wherewithal. Fuller, Netter and Stegemoller (2002) observe that mergers and acquisitions of US subsidiaries are generally financed with cash and these deals tend to be small. We also take account of the possible creation of a dominant new shareholder with the variable CONTROL LOSS. This variable could capture the impact of bidder management aversion to actions that significantly dilute or threaten the control positions of their dominant shareholders. The control loss variable is insignificant, possibly because the privately held firms have multiple owners, who do not necessarily act in concert. Thus, giving these target shareholders bidder stock may not in practice create as large a rival blockholder for the bidder s dominant shareholder. Turning to the other explanatory variables, we find relative size of a target is significantly negatively correlated with the proportion of cash used as a method of payment. This supports Hansen s (1987) asymmetric information prediction that stock financing is more likely as the bidder s information asymmetry with regard to the target s market value rises. The indicator for targets in related industries is also negative and significant, consistent with sellers being less risk averse to accepting buyer stock when it is in the same industry. The runup in bidder stock price has a negative and significant effect on the proportion of cash financing, supporting the arguments that bidders are more likely to use stocks when they are overvalued. This is in line with the empirical findings of Martin (1996), and the theoretical models of Hansen (1987) and Myers and Majluf (1984). 19
Looking at the explanatory variables related to target investment preferences, we expect target shareholders to be more inclined to hold bidder stock when a bidder has promising growth opportunities proxied by a bidder s market to book ratio, MKT TO BOOK. This ratio is an attractive growth measure because it is forward looking. The results are supportive of the argument. Higher ratios are associated with lower proportions of cash (thus, a higher proportion of stock) used as the method of payment. The relationship is statistically significant at the one percent level. This result is in line with the earlier findings of Jung et al. (1996) and Martin (1996). Also consistent with target shareholder preferences, stock is more likely in domestic deals and cash is much more likely in cross border deals; deals where sellers are likely to view bidder stock value as more uncertain. Finally, we use market runup to proxy for the effects of business cycles, but find it is statistically insignificant. The estimated model explains more than 20% of cross sectional variability in the proportion of cash used to finance M&A deals. In the remaining regressions of Table III Panel A, we examine the extent that UK and Irish bidders exhibit different motives from continental Europeans. Since a majority of our M&A sample involves UK bidders, we estimate our primary findings separately for UK-Irish and continental European bidders. In addition, the UK and Ireland are the only common law countries in the sample, which means that this decomposition allows us to assess the importance of the bidder s legal system when it is common law. Distinguishing UK - Irish bidders from other continental European bidders can be particularly relevant because UK - Irish share ownership tends to be less concentrated and the bidder percentage of tangible assets tends to be larger than continental European bidders. In our sample, the average voting stake controlled by a bidder s largest shareholder is 18% for UK - Irish bidders, and 29% for continental European bidders. Furthermore, the percentage of tangible assets is 41% for UK - Irish bidders and only 27% for continental European bidders. Separate Tobit estimates for UK-Irish and continental European bidders are shown on Table III, Panel A regressions (2)-(4). We find that the corporate control and financial variables are important in both samples. The proportion of cash consideration increases significantly when a UK bidder has a controlling shareholder with an intermediate level of voting power, and weakens for relatively high or low 20
ownership levels. For the continental European bidders, the relationship is approximately linear rather than cubic, which may reflect the typically higher dominant shareholder ownership level and a greater bidder concern about losing control. This linear coefficient is positive and statistically significant, which implies that the higher a dominant shareholder s voting control in a bidder, the greater the likelihood of cash consideration. We also find that both UK-Irish and continental European bidders appear to be very reluctant to use stock financing in deals involving unlisted or subsidiary targets. Examining the variables measuring bidder financial condition, we find bidder collateral, financial leverage and asset value are highly significant, supporting the prediction that bidder financial condition has a strong influence on the method of payment choice, with collateral and asset size increasing cash financing and leverage decreasing it. This strongly supports the conclusion that stock financing becomes more common as measures of a bidder s financial condition deteriorate. Overall, the qualitative results for the two subsamples are virtually identical in terms of signs and significance levels. The only other minor differences are that the indicator for bank interlocking directors is marginally insignificant for the UK and Ireland, while the intra-industry indicator and market runup measure are statistically insignificant for continental Europe. In unreported results, we also interact a UK-Ireland indicator with our shareholder control measures and bidder financial condition measures. Using a linear specification, we find the impact of shareholder voting control is greater in the Continental European sample. We also find that the effect of a bidder having a director on a bank s board is significantly weaker in the UK-Ireland, as we would expect given their less bank dominated capital market. We next evaluate whether the financing decision is affected by the origin of the legal system (La Porta, Lopez-de-Silanes, Shleifer, and Vishny, 1998) of the bidder nations. In Table III, Panel B, we further examine the effects of differing legal systems in continental Europe on our prior results by adding indicators for Scandinavian, Germanic and French legal systems and eliminate the intercept term. The coefficients on the bidder nation s legal system indicators measure the probability of cash payment across Scandinavian, French and Germanic legal systems. We find that all three bidder nation legal code indicators are insignificant. 16 In the second regression we augment these indicator variables by adding 21
interaction terms between these legal code indicators and the dominant shareholder s voting power in the bidder so as to assess whether corporate control concerns are substantially different across legal systems. We find that the indicators continue to be insignificant, but the interaction terms are significant and positive for the French and German legal codes. This suggests that these two legal systems create stronger bidder motivations to maintain high voting control, possibly because laws in these countries discourage diffuse shareholdings by their less aggressive insider trading rules and disclosure requirements. These results are also in line with recent evidence by Nenova (2003), who shows that across a sample of Common law, Germanic law, French law and Scandinavian law countries, control premia are lowest for Scandinavian countries. To sum up, our Tobit regression estimates are consistent with M&A financing decisions being strongly influenced by a dominant shareholder s corporate control concerns and the financial condition of the bidder. In addition, the method of payment choice is influenced by a wide variety of other factors related to the specific characteristics of the bidder, target and the deal itself. Further, these conclusions hold for both bidders in the UK Ireland and continental Europe. B. Sensitivity Analysis B1. Additional control variables We assess the robustness of our results by introducing additional deal descriptive variables and by introducing alternative proxies for many of the variables discussed in previous sections. All regressions discussed below are estimated after adding the new variables to the first regression in Table III. Unless otherwise specified, these variables are either added or substituted one at a time. [Table IV goes here] We begin by adding the percentage of cash used in a bidder s last M&A transaction (PRIORFIN) in regression (1) of Table IV. We find this variable has a highly significant and positive coefficient. In regression (2), we examine the explanatory power of the percentage of cash used in prior M&A transactions in the target s industry over the year prior to the announcement (including at least 10 deals), 22